-85-
b. Expected Loss Factor
On the basis of historical experience, bank dealers
generally ascertained a loss factor for each credit rating. The
loss factor represented the bank’s estimate of its credit losses
for each dollar of credit exposure in that credit rating. The
loss factors were generally derived from the bank’s experience
with loans to borrowers with the respective credit ratings.
c. Loan Equivalency
i. Overview
A bank would typically establish a credit limit for each
customer, and the loan equivalency measurement of credit exposure
was used by banks in applying credit limits. The loan
equivalency amount focused on the bank dealer’s expected credit
exposure from a specific counterparty with which it had entered
into one or more swaps. The loan equivalency amount represented
the amount of the counterparty’s credit limit, as established by
the bank, that was consumed by each swap. In other words, the
exposure model determined the number of swaps that the bank could
enter into with the counterparty and stay within the prescribed
credit limit.
ii. Types of Credit Exposure
The concept of credit exposure was broken into current
credit exposure and potential credit exposure. There also is a
third type of credit exposure known as “expected exposure”.
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